This is Part 2 of 3 in a short series on Small Business Finance. It has been my experience that many Entrepreneurs don’t collect, review and plan for financial operations of their business in an organized and consistent way. Entrepreneurs are busy performing many task and are often challenged in understanding small business finance. I want to help you meet this challenge.
In Part 1, we reviewed a Collection System for your business finances. In this post, we’ll lay out a system to review and analyze the financial information you are now collecting. Let get started building the small business finance tools you need!
A quick reminder, if you haven’t signed-up for our “Know Your Numbers” video series on Small Business Finance you can do it right here.
Small Business Finance System
The best way to get a handle on your business is to create a business system around it. A business system is just a set of instructions on what to do, when to do it, and how to do it.
If you create a simple small business finance system for your business, you’ll have what you need to:
- Make better decisions
- Make more money
- Maintain control
Step 1 Create a Collection System
We covered this in a previous post.
Step 2 Review and Analyze System
Ok, you have your financial reports but aren’t sure how to review and analyze them. Your financial statements provide a lot of answers but you need to know the right questions to ask first.
7 Key Financial Questions
- Do I have enough cash to meet current expenses?
- Are my customers paying me on time?
- Do I have too much inventory (manufacturing or wholesale industries) or unbilled time (service industry) on hand at the end of the month?
- Are we paying our bills too fast or too slow?
- Are we on track with our revenue plan?
- Are expenses in line with revenue plan?
- What financial areas do we need to focus on in our business?
Financial Statement Review System
The first thing you should do is a high level review of your financial statements. On your Balance Sheet, focus on your total current assets and total current liabilities and look at the dollar difference between them. This dollar difference is your working capital and is a measure of your capacity to pay your bills. Higher working capital means less sleepless nights wondering how you are going to make payroll.
Next, review your Profit and Loss statement for the amount of sales, gross profit and administrative expenses. It’s helpful to review your Profit and Loss statement by calculating individual accounts as a % of sales. The common calculations include:
- Cost of Goods Sold
- Gross Profit
- Salaries & Wages
- Net income before taxes
Once you review your financial statements a few times, you’ll be able to do this quickly and efficiently.
Tip: Compare your reports with prior months or prior years to understand the trend. It’s important to know where you are but it is more important to know where you are going.
Financial Statement Analysis System
A great way to “ask the right questions” about your financial statements is to use a common set of financial formulas or ratios. I went ahead and prepared an Excel worksheet with the formulas already created to make the set-up easier. In order to download the Financial Ratio worksheet just fill out the form below and we’ll send you an e-mail with a link.
The ratios are organized into 4 categories:
- Liquidity Ratios-measure yours ability to meet your current obligations. A result greater than 1.1 is desired.
- Profitability Ratios-measure the gross and net profit as a percentage of sales. A positive % indicates profits and in most cases, the higher the better.
- Leverage Ratios-measures how much leverage you have in your business. A result of 2.0 indicates you have borrowed $2.00 for every $1.00 of equity. A result over 3.0 is an indication of high leverage.
- Efficiency Ratios-measures how quickly assets and liabilities are converted into cash. When cash flow is low, these ratios will give you some insight into your cash flow cycle.
In order to take the analysis one step further, comparing your results to your industry will give you some perspective on how you are doing.
Step 3: Planning System
In Part 3 of this 3 part series we will outline a planning system for your business. Planning is easier when the first two parts of the system are in place. A planning system will keep you on track to achieve the results you want faster than ever thought possible.
“Planning is not about predicting the future; it is about creating your future.”
Join me for Part 3!